Why industrial growth should pick up?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Industrial growth had slowed down since September 2010 to nearly 3 pct with some improvement in March this year. There are reasons why performance had been uneven though there are also reasons why growth will pick up in future.
The current IIP with 1993-94 base is no longer representative of industrial production. With development and technology change, a number of products have lost their weight in the index and a number of new products have surfaced. The new index with 2004-05 base which will be used from June will reflect genuine conditions.
That does not belittle the fact that growth had slowed down. The main reasons are three. First, the statistical illusion about growth. Growth was low yr/yr because in the eight months since Oct 2009 growth was high. Again, that was not because industry performed well but because the previous year’s growth was down due to world recession.
A better way to measure growth is month/month. That indicates how the industry is really moving. For instance in March this year, industrial production increased 16.9 pct over February though yr/yr growth was 7.3 pct. Surely, growth could have been higher but for two other factors which hit, by turns, consumption and investment.
Take consumption first. Demand for manufactured goods weakened because inflation was higher in agriculture than in industry. The difference in the two rates of inflation was 13 pct. People used to spend, on average, 15 pct of their income on food but because food inflation was higher they were required to spend an additional 2 pct of income on food. That left less money to be spent on manufactured consumer goods and demand declined.
The third factor that has been much talked about is the high rate of interest. There are interest sensitive sectors like construction, heavy industries (e.g. infrastructure), which are affected when interest rate is raised. The RBI did it at every policy review, taking the repo rate up 200 bps. Banks in turn put up their own borrowing and lending rates. Industry now has to borrow at 14 pct. With the short rates, the long rates also edged up delaying investment decisions.
Apparently, the drop in industrial growth since September 2010 is partly illusory and partly real. There is already a drop in food inflation and if the government does not rush in to increase the minimum support prices, food inflation has a good chance to stabilise. That will increase the demand for manufactured consumer goods and accelerate industrial growth.
The interest rate will still remain a matter of concern. For, even if inflation comes down, the RBI will take time before it cuts the repo rate. Hence, consumption will increase in 2011 but investment may stagnate unless the new industrial policy which is aimed to push growth to 12 pct provides a strong stimulus. That is undoubtedly doable if simultaneously there is abundant investment in infrastructure particularly power. In any case, the new index with a new base will reflect better performance.